Scaling into reversals to gain an edge

Although the adage “never add to a losing position” generally is good advice, most experienced traders also know that every rule has its exception. Many successful traders believe that they cannot pick an exact top or bottom reliably, but they are confident they know when one is forming. When that is the case, they often will choose to enter in stages, known as scaling into a position. Dollar-cost averaging is a widely used example of this practice. Traders can scale into shorts as they attempt to pick a top, or into longs when they expect a bottom. Here, we’ll examine this concept in the context of entering a bear trend.

Scaling into reversals is not for beginners because it is betting against a trend. Usually when traders buy in a bear trend, they scalp for small profits. Such scalp trades are not necessarily advisable for beginners (see “Determined downtrend,” below). Beginning traders should wait for a major trend reversal to form. There should be a strong rally that breaks above the bear trendline, and then a weak resumption of the bear trend. At that point, a reversal up becomes a major trend reversal buy signal.

Probability forms the basis for scaling into a trade. When the market is in a strong breakout, the probability of the move sustaining profitability often is 60% or more. However, 90% of the time, the bulls and bears are evenly balanced, and the probability of a profitable trade is between 40% and 60%. The result is that great traders spend most of their lives comfortably living in a gray fog. Scaling into positions is one tool that can give them an edge.